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Explained: What investors should look out for before putting money in an IPO

The sharp revival in equity markets has catalysed the primary markets, and as many as 27 companies have filed offer documents with the Securities and Exchange Board of India (SEBI) over the last couple of months.

With foreign portfolio investors (FPIs) making a strong comeback — the benchmark Sensex has reclaimed the 60,000 mark — merchant bankers have lined up public issues to take advantage of bullish domestic retail and FPI investor sentiments. While there has been no new listing since May 24, the cycle is set to restart with the listing of Syrma SGS Technology later this month. The issue closed for subscription on Thursday. Many more are lined up — Utkarsh Small Finance Bank, Fincare Small Finance Bank, and GO Digit General Insurance have filed their offer documents with SEBI.

How are the IPOs that came during the previous market boom faring?

2021 witnessed a record number of IPOs and fund-raising. While 63 companies came with public issues to raise funds amounting to a record Rs 118,723 crore from the equity markets in the calendar year, only 18 issues have hit the market in 2022. Collectively, they have raised Rs 40,310 crore — and half of this amount has come from just one issue: LIC.

A large number of public issues that hit the market amid soaring valuation in 2021 are now trading below their issue price. Data from NSE show that 27 of the 63 issues that hit the market in 2021 are trading below their issue price, including high-profile ones such as One 97 Communication (Paytm) and Zomato.

On the other hand, of the 16 issues that hit the market in calendar 2022 when the markets were less buoyant and the indices were on a decline, only four are trading below the issue price.

“We always witness a bunching-up of issues when the secondary market is buoyant. Most issues that come in times of sharp rally in the markets tend to be overpriced, and are susceptible to sharp declines when the market weakens. On the other hand, IPOs that come during normal times fare much better as they tend to be priced reasonably,” a fund manager who did not wish to be named, said.

So should you invest in this IPO rush?

The 18 per cent rally in the benchmark indices at the BSE and NSE since June 17, coming on the back of sharp FPI flows and a revival in investor sentiment, have encouraged merchant bankers to line up issues. For retail investors looking to play in the primary market, however, experts advise caution. They say that retail investors should seek out good-quality stocks from the bouquet of existing listed companies, and pick up the ones that are undervalued and not leveraged.

Several high-profile new age tech companies that came with their issues in 2021 are trading below their offer price — market participants say investors should be cautious, as there is a lot of irrationality around start-ups when there is liquidity in the market.

“When the market weakens, investor confidence in these companies gets shaken even on minor negative news flows. In the case of most of these companies where profitability is not visible for the next five years, it is very tough for an investor to stay invested when the market weakens, and so one has to be very careful about which company and at what valuation they are investing,” the head of research with financial services firm said.

What should you look for before investing in an IPO?

An IPO is an asset class that is a derivative of the secondary market, and its performance is linked to the sentiment in the broader market. Demand tends to be strong when investor sentiment is buoyant, and in such a scenario they get higher investor interest and fare well. However, that is not true for all cases; it also depends upon the pricing of the issue. Hence, investors need to do a thorough study of the company — the quality of promoters, business fundamentals, and the financial and peer review analysis — before investing in an IPO.

Corporate governance practices in the company should be given top priority. A good peer review is a must: Investors must study other listed companies in the sector and compare their growth, and their PE ratio (market price to earnings per share). If the company coming with an IPO is demanding a higher valuation, investors can consider avoiding it.

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Domestic institutional investors (DIIs) were active buyers last week when stock markets faced a nervous sell-off with foreign portfolio investors (FPIs) dumping stocks across the board.

While foreign investors exited from stocks worth Rs 25,000 crore ($3.34 billion) in the last six sessions, DIIs accumulated stocks worth Rs 12,818 crore during the same period. Domestic institutions have been using every major correction to buy into stocks and reshuffle their portfolios. The benchmark Sensex nosedived 2,901 points, or 4.83 per cent, to 57,107.15 in the last six sessions.

On Friday, when the Sensex fell 1,688 points, FPIs pulled out Rs 5,785 crore from Indian markets while DIIs invested Rs 2,294 crore, according to data available from stock exchanges. On November 24, when the Sensex declined by 320 points, FPIs sold Rs 5,122 crore stocks but DIIs were buyers of Rs 3,809 crore worth of stocks. Insurance companies led by LIC and mutual funds are the major players in the market, absorbing the sales triggered by FPIs.

“Domestic institutions follow the policy of ‘buy when others sell’. They are long-term players and utilise every opportunity to get stocks cheap,” said an analyst.

In November so far, FPIs have taken out Rs 31,124 crore from Indian markets while DIIs invested Rs 20,598 crore. LIC alone usually invests around Rs 50,000 crore in the markets every year.

Analysts are worried about the sell-off continuing in the wake of several uncertainties relating to the new Covid variant and tightening of the monetary policy in the United States. The sharp correction in the market on Friday was mainly triggered by concerns arising out of the new strain of the virus spotted in Africa.

In March 2020, when the Covid pandemic first hit the world, the market crashed with FPIs pulling out Rs 65,816 crore. However, DIIs which bought Rs 55,595 crore worth of stocks made a good profit as markets bounced back subsequently.

Setting the stage for further downward pressure on other world markets, the Dow Jones Industrial Average in the US on Friday dropped about 905 points, or 2.5 per cent, for its worst day of the year, while the S&P 500 and Nasdaq Composite slid 2.3 per cent and 2.2 per cent, respectively. The Dow was down more than 1,000 points at session lows.

The big question is whether retail investors will follow the exit route taken by FPIs. Retail investors have been pumping money into the stock markets through SIPs of mutual funds in the last 12 months. Another possible impact of the market rout will be on the IPO market which has been witnessing a flurry of activity with the entry of high-profile unicorns.

The FPI sell-off can accelerate if the US tightens monetary policy. “Foreign brokerages had downgraded India early this month on high valuations. India’s valuations vis-a-vis emerging market peers also became stretched. The further negative trigger came from the RBI observation that valuations are stretched,” said VK Vijayakumar, chief investment strategist at Geojit Financial Services.

The market action next week will depend on how the new virus strain spreads and its impact on the world. There are concerns over rising inflation in the minutes of the recent US FOMC meeting, signalling higher chances of an aggressive policy tightening. Worries over overvaluation and a possible rate hike have been haunting foreign investors.

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